Two-sided markets and their relevance for competition policy

Contents

Introduction

1 An attempt to define two-sided markets
1.1 Existence of two or more groups
1.2 Getting and keeping critical mass

2 Dynamics of two-sided markets
2.1 Network effects
2.2 The chicken-and-egg problem
2.3 Multihoming

3 Economic rationale behind two-sided markets
3.1 Deciding optimal pricing structure
3.2 MC irrelevant for profit maximization

4 Relevance of two-sided markets for competition policy
4.1 Market Definition – SSNIP test
4.2 Market Power
4.3 Barriers to Entry
4.4 The Efficiency Factor
4.5 Predation
4.6 Other Issues

5 Concluding Observations and Suggestions

Appendix I: Examples of two-sided markets

Appendix II: Illustration of Multihoming: Credit Cards

References

Introduction

Two-sided markets consist of two or more exclusive groups, present simultaneously on a single platform. They both need each other. In order to succeed the platform provider must ensure active participation of both groups. In the beginning these bazaars face chicken-and-egg problem, which should be solved, sometimes even by providing free chicken. These markets include some of the most important industries in new economy such as mobile telephony companies, free TV services, OS suppliers, software providers, gaming companies, credit card companies, auction sites etc. Ebay and amazon are good examples of two-sided markets. In such two-sided markets buyers and sellers first trade with the intermediary/ies so as to gain access to the functionalities of a platform and then trade with each other under oligopolistic conditions.^[1]

In chapter 1 of this paper an attempt has been made to describe finer nuances of two-sided markets. Thereafter I proceed to discuss the various dynamics of two-sided markets in chapter 2. Two-sided firms differ from traditional industries and they follow totally different business economics. Marginal cost does not help them in deciding optimal price. Pricing policies and other business strategies must be formulated in such a way that it should ensure active interaction of both groups. Pricing strategy should get both sides on board and should also solve chicken-and-egg problem. Chapter 3 describes the pricing policy adopted by two-sided markets. Chapter 4 deals with relevance of two-sided markets for competition policy. Competition Authorities do not need different set of rules to regulate these industries. However Competition Authorities must consider various economic principles that influence pricing and investment decisions in two-sided markets.

1 An attempt to define two-sided markets

Two-sided markets can be defined as existence of a platform on which special services are sold or bought, managed by third entity.^[2] As per my opinion this definition is not descriptive enough, because this definition does not include free TV companies. Free TV as well as Pay TV companies are examples of two-sided markets, because they bring together viewers and advertisers. Rochet and Tirole go for more exhaustive definition of two-sided markets. In their opinion, two-sided markets are roughly defined as markets in which one or several platforms enable interaction between end-users, and try to get the two (or multiple) sides on board by appropriately charging each side. That is, platforms court each side while attempting to make, or at least not lose, money overall.^[3] They put more emphasis on pricing strategy in two-sided markets, while defining two-sided markets. Bruno Jullien writes that at the intuitive level, the concept of two-sided markets refer to situations where one or several competing “platforms” provide services that are used by two types of trading partners to interact and operate an exchange.^[4] Recently in an interview David Evans said that two-sided markets are those in which entities we called catalysts bring together two (or more) groups of customers who need each other in some way, but who cannot capture the value of the mutual attraction on their own.^[5] He emphasized on the mandatory presence of third entity for two-sided markets. He also says that these two (or more) groups need each other and cannot realize their full potential without active interaction.

In nutshell a market could be described as two-sided if there are:

a. Existence of two or more groups (Refer Appendix – I)
b. Benefit enjoyed by one group is positively related with number of participants in the other group
c. Presence of third entity is necessary to realize these benefits created by one group for the other group.

1.1 Existence of two or more groups

Two-sided markets are different from traditional one-sided markets. In two-sided market there exist interdependency among two (or multiple) consumer groups. They need each other. Additionally there is need for a facilitator or catalyst to achieve full potential.

In one sided markets suppliers use supply chain to deliver their product or services to their customers. Each segment is completely independent of other. Demand of particular product is not dependent on other participant in the process. In two-sided market existence of two distinct groups and interdependency amongst them is the defining characteristic of the business. In the absence of a catalyst, who facilitates such mutual interaction, these groups cannot realize their full potential.

Mobile telephony is an example of two-sided markets, and with the introduction of additional facilities, it is fast becoming multi-sided. From various perspectives mobile company is a two-sided market. Firstly mobile network bring together callers and receivers. Additionally modern mobile network are built on an operating system, which needs developers to write software in such a fashion that it makes more attractive to subscribers.

Ebay and amazon are also good examples of two-sided markets. In these bazaars there are two groups of customers. They both need each other. A transaction takes place, when both are involved. Platform providers merely act as facilitator. To succeed they must get involvement of both types of customers.

1.2 Getting and keeping critical mass

As we read earlier in two-sided market there exists dependency between at least two groups. And to realize their full potential there must be mutual interaction among these groups. Presence of both sides is very critical for a successful two-sided market. Getting both sides on board is prime aim of platform provider. Every new participant brings more benefits to other participants. Getting and keeping this critical mass require different business economics. Very often subsidies are given on either side of the market to attract customers.

Dating club can be seen as traditional example of two-sided market. There business can be successful only if they attract enough members of opposite sex to their club to make a match likely. They need to formulate an effective pricing policy, so as to attract enough number and mix of patrons from both sexes and simultaneously generate enough surpluses to survive. One club does this by charging men $100 for membership, plus $20 a visit, and letting women in for free.^[6] This is probably based on assumption that equal pricing policy may not help in getting critical mass.

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^[1] See Francisco Ruiz-Aliseda, P.1

^[2] See Roson Roberto, P.1

^[3] See Rochet and Tirole, P.2

^[4] See Bruno Jullien, P.2

^[5] See Marc Bourreau and others, P. 97

^[6] See David S. Evans, P.1